The Reserve Bank has added a further NZ$739 million to its 'foreign currency intervention capacity' in the past month and now has nearly NZ$18.5 billion held in offshore currencies to intervene if needed in foreign exchange markets

The Reserve Bank is continuing to build up its war chest of foreign currency in the event that it needs to intervene in the foreign exchange markets.

This is according to the RBNZ's foreign currency assets and liabilities monthly figures, which show that the RBNZ's 'foreign currency intervention capacity' was increased by some $739 million in October.

This means that our central bank has now increased the amount of its foreign currency assets available for currency intervention by over $5.5 billion since just June of this year.

The total amount available is now $18.464 billion, which is an increase of some 42.9% on the amount held by the central bank as of June. The full figures are contained in the abridged spreadsheet at the bottom of this article.

Earlier this year the RBNZ indicated that it was going to put more of its assets into foreign currency.

The RBNZ announced that it and the then Finance Minister Grant Robertson had agreed to a "new framework" for managing foreign reserves. As part of this, the amount held in offshore currencies would increase - but the RBNZ's not telling us by how much.

In recent years the bank had fairly consistently maintained a level of around $12 billion worth of foreign currency available for intervention. So, at nearly $18.5 billion now, the amount available has already been increased significantly.

However, the RBNZ has made clear it is nowhere near finished building up the foreign currency war chest yet.

In a recent speech RBNZ Assistant Governor Karen Silk said there was no clear answer to the question of what the right level of foreign currency reserves the Reserve Bank (RBNZ) should hold.

"We will not be commenting on the target level of reserves agreed as that information is considered market sensitive but will note that achieving it is a process that will occur over a number of years. This is because we seek to avoid undue risk to market liquidity from our actions in reaching agreed levels," says Silk.

The big and noticeable move the RBNZ made earlier this year was when it sold nearly $4 billion of New Zealand currency in July. However, it doesn't just raise its overseas currency holdings by directly selling New Zealand dollars.

Silk explained this in her speech:

"Unhedged reserves are raised by selling NZD in exchange for foreign currency in the spot foreign exchange market. This transaction results in us owning foreign currency, and the value of these assets will fluctuate in line with increases or decreases in the exchange rate," says Silk.

"The hedged reserves are raised by lending NZD in exchange for foreign currency, generally in the cross-currency basis swap market. We effectively borrow foreign currency under long term contracts and are not exposed to movements in the exchange rate, because all the foreign exchange rates are agreed at the start of the contract."  

"Historically the RBNZ has chosen to hold a mix of both unhedged and hedged reserves. In addition to the different exchange rate exposures, there are other considerations taken into account when determining the mix. These include the relative costs, risk appetite, refinancing risk and intervention needs. While we will not comment on what the composition will look like in the future, we expect the mix of portfolios to carry flexibility and be influenced by market conditions over time," Silk said.

Westpac New Zealand Chief Economist Kelly Eckhold, who formerly worked as the RBNZ's manager of foreign reserves and at the International Monetary Fund, said in a recent episode of interest.co.nz's Of Interest podcast that the RBNZ's foreign currency intervention capacity is likely to increase significantly over the next two or three years.

Eckhold pointed out the RBNZ's total level of foreign reserves hadn't changed substantively since 2008, and the economy's about 80% bigger now and the foreign exchange market has probably doubled in size. The RBNZ has intervened in currency markets sparingly in the past, and the new framework doesn't mean this will change.

"When you see this rather large and abrupt change in the level of reserves going on here it's a consequence of the fact that the framework hasn't been reviewed for a very long time," Eckhold says.

"We have a well functioning foreign exchange market. The purpose of having the intervention policy for crisis situations is to keep it that way at all times," he says.

From a monetary policy perspective the RBNZ may intervene when the NZ dollar "overshoots or undershoots relative to its justified or fundamental levels." It's a tool available to "lean against some of those really large unjustified deviations in the exchange rate."

"With respect to the crisis intervention role, what it really does is help provide a bit of insurance in the event that some relatively rare but bad situations occur. And one of the good things about insurance is that it makes people probably a little bit more comfortable investing in the country because they feel there's some buffers there that could be used if something bad happens. That probably means all else equal your interest rate's a little bit lower, potentially your exchange rate could be a little bit less volatile, and that's going to be to the benefit of ordinary New Zealanders and firms," Eckhold said.

(There's detail in this story on the RBNZ's approach to intervening in the currency markets).

The RBNZ describes the foreign currency intervention capacity as foreign currency assets that are readily liquefiable less foreign currency liabilities that fall due in the next 12 months.